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Over the past few months, the global economy has been confronted with a number of fundamental shocks. Price movements in key markets have been sunstantial. In particular, this has been true of both oil and other commodities. We have also witnessed a significant readjustment in the value of the main currencies and, in particular, a pronounced strengthening of the US dollar. Added to this are the effects of the European Central Bank's Quantitative Easing, which has pushed European yields down to all-time lows. Such fundamental changes have far-reaching effects on the growth outlook of many countries. While these are a major support factor for numerous developed countries, especially in the eurozone, they pose a considerable challenge for a number of emerging countries.
Traditionally, a significant part of borrowing by sovereign states and corporate entities in emerging countries has been denominated in foreign currencies, and particularly the US dollar. This phenomenon faded somewhat after the Asian crisis of the late 1990s and the Argentine default of 2001. However, US dollar borrowing in emerging countries has risen again since 2007, as shown by figures published by the International Monetary Fund (IMF) in its latest Global Financial Stability Report. Since the 2007-8 crisis, many sovereign states and corporate entities have indeed sought to take advantage of low US interest rates by borrowing in dollars.
Substantial borrowing in foreign currencies may be a source of vulnerability for a sovereign or corporate entity, since it exposes the entity in question to fluctuations in the currency market if a significant part of its income is denominated in local currency. In particular, the sharp rise in the US dollar relative to most global currencies over the past year constitutes an immediate challenge to a number of sovereign states and corporate entities in emerging countries. In theory, there are ways to hedge this exposure, for example using derivatives. However, such hedges are often not put in place because of the associated costs. In some cases, a sovereign state or a corporate entity might also benefit from a natural hedge if a significant portion of its income derives from global markets and is denominated in foreign currencies. For example, income received by commodity exporters is typically denominated in foreign currencies. Many countries – particularly in Latin American and Africa – derive a substantial proportion of their income from commodity exports: oil, copper and other metals, coffee, cocoa, etc.
However, these commodity exporters are now facing a second considerable challenge: the collapse in the price of many commodities on global markets. Slowing demand in China is undoubtedly a key factor in the decline observed in recent months. Indeed, price falls are not confined to oil, as indicated by the sharp decline in global commodity price indices such as the CRB (Commodity Research Bureau) index, shown in the chart below. Growth in some countries – for example Brazil – has already suffered as a result. More generally, the example of Brazil shown in the chart illustrates the strong relationship between the country's rate of economic growth and the evolution of commodity prices.
Since the reforms were carried out, companies have significantly boosted their hiring, although in many cases the new jobs have come with part-time or temporary contracts. Overall, job growth recently climbed to nearly 2.5% (Chart 1) and unemployment has started to decline gradually. The renewed job growth has caused private consumption to pick up as well. Household consumption rose by 2.4% in 2014. The latest confidence data show that consumer sentiment has improved markedly.
Sources: Macrobond, BGL BNP Paribas
A number of studies have shown that commodity prices and, more generally, terms of trade – i.e. the value of a countries' exports relative to its imports – are key risk factors in emerging markets. The state of public finances in such countries and the risk of default by sovereign states in particular are strongly related to trends and volatility in commodity prices on global markets.
In its latest Global Financial Stability Report, the IMF speaks of rotating risks. According to the IMF's analysis, this rotation is not limited to a displacement of risks from developed countries to emerging countries; it also includes a displacement of risks from the banking sector to other parts of the financial sector and from solvency risks to liquidity risks. These new risks will need to be closely monitored over the months and years to come.
BGL BNP Paribas
Published in the Luxemburger Wort (in French) on 8 May 2015.